US Default on Debt: Why Congress Must Raise the Debt Ceiling

The US government shutdown that went into effect on October 1, 2013 (day one of Fiscal Year 2014) is bad enough, with regular services and operations suspended and all non-essential personnel furloughed. What is worse, however, would be if the US Congress fails to raise the "Debt Ceiling" on (or before) October 17, 2013.

What is the Debt Ceiling? 

The New York Times and BBC both have great bullet-point articles on the Debt Ceiling. The main gist is this: 

• The Debt Ceiling is the limit on how much money the government can borrow by issuing bonds and securities.
• The President proposes a budget, Congress amends it as they see fit and they pass it back to the President to sign into law. The government routinely passes spending bills without consideration of how they are funded, and as a result the US federal government has had to borrow money to cover the budget deficit every year since FY 1940 with the exception of the 12 fiscal years (that's 12 out of 73 years, or 16% of the time) when the government actually had no deficit/ran a surplus. 
• The other 61 fiscal years between 1940 and 2013, the government ran a deficit. To finance operations the Treasury continually sells Treasury Bonds and Securities (debt) to investors. The US government is responsible for interest payments on those bonds, and repayment of the principal value of the bond when it matures. Technically, the government can keep selling bonds to cover the amount it already owes in order to cover the expense of paying interest and mature bonds. This amount aggregates over time and has become the US National Debt, which as of Oct 4, 2013 stands at $16.7 trillion.
• Raising the Debt Ceiling authorizes the government to issue more bonds to pay the money it already owes-- namely interest payments and principal on bonds and securities it has issued. The Debt Ceiling has been raised almost every year (on average) since 1940 with no problem-- until certain members of Congress were elected in 2010. 
• The US Constitution requires the government to pay its debts, so a default would be unconstitutional, on top of having horrifying consequences in the US and abroad.
• According to the Congressional Budget Office, debt management options will run out sometime between October 22 - October 31 if the debt limit is not raised on or before October 17, 2013.

Since 1940, Congress has raised the Debt Ceiling 82 times.*

*The Debt Ceiling was reduced only a handful of times out of approximately 92 adjustments since 1917.

Raising the Debt Ceiling is necessary to make the payments that the US government has already promised. It has no effect on actual budgetary concerns unless Congress fails to raise it. If that happens, the US will default on its debt within 14 days, credit agencies will downgrade the US government's rating (remember what happened in August 2011 when Congress threatened to not raise the Debt Ceiling?) and investors who buy Treasury Bonds and Securities will demand higher interest payments.

Right now interest on US Bonds is so low that an investor is practically paying the US government to hold his money for him because the yield rate on a 10-year bond can easily be outpaced by inflation (and even longer term bonds like 20 or 30-year bonds are paying pretty slim amounts). So issuing bonds right now to pay off the US government's previous debt obligations could actually be a very smart move.

Being forced to issue bonds at higher interest rates would mean that, while US Bonds may become a more attractive investment to people who actually want to make money instead of having a safe place to hold it, a larger portion of the federal budget would go toward paying off interest on the National Debt. That could lead to larger deficits and possibly additional defaults... and certainly would have as much, if not greater, impact than the Financial Crisis in 2008.

Remember how scared everyone was of the global impact of a debt default in Greece? ...Well, Greece is not the United States.

For more information on why the National Debt isn't really a problem (unless Congress fails to raise the Debt Ceiling), see my previous blog post "The Public Debt: A Menace to Society?"

The US created the Debt Ceiling in 1917, mostly to fund WWI, but also to cover any other borrowing the government may need to do in the future. Many other countries don't even have a "debt ceiling"-- they either just borrow whatever is necessary to cover their deficits, or they  must work within budget restrictions by appropriating funds for each initiative.

Political division has been particularly contentious during the Obama administration, with many members of Congress (mostly in the House of Representatives) effectively "holding the nation hostage" in order to delay or prevent several Obama initiatives like the Affordable Care Act, and also to push their own specific agendas that would otherwise not pass.

What Can Be Done?

It's in the hands of Congress. If you are a US citizen, you can call or write to your representatives and encourage them to raise the Debt Ceiling. Congress can raise, eliminate, or enact automatic increases to the Debt Ceiling. Any of those actions would avert a debt default. Congress could also draft new legislation that provides a framework for fiscal responsibility-- although there really isn't time for that now.

President Obama could choose to ignore the debt limit and authorize the Treasury Department to issue bonds without Congressional approval, but that would be a violation of the Second Liberty Bond Act of 1917 that created the limit. Certain members of Congress may consider that an impeachable offense. On the other hand, not raising the Debt Ceiling is effectively the same as defaulting on current debt, is unconstitutional (US Constitution, 14th Amendment, Sec. 4), and could reasonably be argued to be a matter of national security and global stability.

To avoid US debt default and avert a global financial meltdown, Congress must raise the Debt Ceiling on or before October 17, 2013.  

Supplementary:

Fiscal Years Since 1940 without US Federal Budget Deficit and the Sitting US President

Clinton

FY1998-2001 

Total Surplus (2011 dollars): $726.3 billion

Johnson

FY 1969

Total Surplus (2011 dollars): $19.5 billion

Eisenhower

FY 1960,  FY 1956-1957

Total Surplus (2011 dollars): $66.8 billion

Truman

FY 1951, FY 1947-1949

Total Surplus (2011 dollars): $244.6 billion

The Public Debt: A Menace to Society? - GD Part 4.2

In the wake of the Financial Crisis, the Private Sector struggled to regain its losses, while the US government sought to stimulate recovery with an array of efforts: 
Quantitative Easing, the Stimulus Package, TARP, extending the length of Unemployment Insurance coverage, extending the Bush Tax Cuts and instituting a Payroll Tax holiday, among other tactics.

But since the Great Recession that followed the Financial Crisis also created a reduction in income for the people, it consequently caused a revenue reduction for the government. This has led to massive government spending and growing deficits.

Is the United States going broke? 


Public Debt vs. Private Debt

Let's look at a graph of US Public Debt (AKA the National Debt or the Federal Debt) and Private Debt. The graph is plotted with the most recent data (2012) on the left, with data from each past year heading to the right. Dollar amounts are in billions, and the figures are adjusted for inflation (2011 dollars). The data was compiled from various documents available through the US Treasury Department and the Federal Reserve websites.

2012 figures for each category in the above graph:

Federal Government (US National Debt): $16.022 trillion
Domestic Financial Sectors: $13.855 trillion
State and Local Governments: $3.003 trillion
Non-Financial Business: $12.008 trillion
Households (Individuals): $12.945 trillion

Private Debt totals $38.808 trillion.
The total of all debt in the United States- both Public and Private- is $57.833 trillion.

Debt in the United States is a growing concern- both in the Public Sector and in the Private Sector of the economy. But is it a crisis? This is a big topic, so I'd like to split it up into smaller chunks.

With the “sequester” looming overhead and the constant battle in Washington, D.C. over spending and deficits, there is much talk about the National Debt (or the Federal Debt/Public Debt). This piece will concentrate on what the debt is, how it works, and if it really is a crisis-- or if it's just political grandstanding.

Federal Debt

While the Federal debt is the largest single category of the total debt in the United States, it's important to point out that about one-third of it ($4.85 trillion) is owed between different departments of the government- the Treasury Dept. calls these "Intra-Government Holdings" - of the remaining $11.6 trillion, more than half (about $6.1 trillion) is owed to US citizens and businesses or other domestic private interests who have bought Treasury Bills and US Bonds. The rest ($5.5 trillion) is owed to foreign countries. However, foreign governments owe the US government approximately $0.89 for every $1.00 of debt the US has borrowed from other nations.

So if the whole world were to decide to settle all international debt outstanding, the United States would be paying out about $5.5 trillion to foreign governments, but would be paid back around $4.8 trillion. The difference is then about $700 billion, or roughly the amount that the US spent on the Department of Defense in 2011.


Debt Growth

The growth rate of the debt is very concerning, especially when depicted this way:

When depicted in raw dollar amounts, not adjusted for inflation, the National Debt looks quite daunting.

However, it's not really relevant to depict the National Debt in non-inflation adjusted raw dollar terms. A better way to judge, both for historical context and in terms of the US's ability to pay, would be as a percent of GDP.

Note: this next graph is plotted in the opposite direction.

As you can see, in terms of debt as a percent of GDP, the US was in a similar situation following World War II. 

Read from 1929 (far right) to 2012 (far left), the above graph depicts Federal Debt (the National Debt) relative to the size of the US economy. That big spike on the right-hand side is the result of World War II spending.

Following World War II, the US had a drastically expanded industrial sector and a labor force specifically trained to work in it. The US was uniquely positioned to become the greatest economic power in the world in terms of manufacturing and finance. 

The rest of the industrialized world was more or less in shambles, and the United States was able to swap debt around as it funded the reconstruction of Japan and large swaths of Europe.

The above graph kind of puts a different spin on the Reagan campaign leading up to the 1980 Presidential Election. Reagan criticized Carter for being a "big spender"- increasing the budget deficit and National Debt- which seemed like a big deal since the US was in the middle of a recession. Yet since 1932, the National Debt had been lower as a percent of the GDP only twice before- in 1979 and in 1974. Ironically, Reagan then went on to triple the National Debt in the subsequent eight years.

Today, much of the US's manufacturing has moved overseas and the government's fiscal gains from the economic boom of 1950's-1970's were virtually erased by what is known as the Reagan Buildup. 

While headway in reducing the debt was begun by the government during the late 1990's, the US soon had a series of economic and political crises. 

The 2000's brought them on relentlessly: the Dot-Com Bubble bust, followed by the September 11th Attacks, more than a decade of conflict in Afghanistan and Iraq, the Financial Crisis of 2007, TARP & other subsequent government bailouts, large perennial expenses like the War on Terror, the newly created Department of Homeland Security, and now the Great Recession-- which seems to be dragging on and on despite everyone's best efforts.

From a purely capitalist perspective, the main focus for a recovery for both the economy as a whole and the National Debt (if it really is a problem at all) should be to rebuild the US manufacturing base and to implement policies that encourage banks to lend, employers to hire, and individuals to spend their money. However, the two major capitalist political parties in the US differ significantly in what those specific policies actually are, which is why the US is facing the greatest partisan gridlock in Washington D.C. since the end of World War II.

US Federal Government Budgets

Quickly, so everyone's clear:

Revenue is how much money the government takes in each year from taxes, tariffs, and other payments. 

Expenditures are what the government spends.

The Deficit is roughly the amount a government has to borrow (usually by issuing bonds) to cover expenditures that exceed revenues each year. There are other financial reasons why a government may issue bonds and borrow money, but we're not going to discuss those now.

The National Debt (the Public/Federal Debt) is the running total of how much debt the government has outstanding/unpaid. The only time the US ever fully paid-off its debt was in 1835. It began borrowing again within a year.

The short bars on the graph between 1976 & 1977 correspond to a period known as "TQ," or Transition Quarter- and this represents a time when the beginning of the Federal Fiscal Year was moved from July 1 to October 1.

In the above graph, which is adjusted for inflation (billions of 2011 dollars), the blue bars represent Revenue (how much the government collected in taxes and other sources), the green bars represent expenditure, and the downward-facing yellow bars are the deficit for each year (yellow upward facing bars signify surpluses). 

The moderate yellow streaks on the far right are WWII spending. The huge yellow bars on the left represent deficit spending after the 2007 Financial Collapse. 

It looks pretty bad until you draw the same data as a percent of GDP:

So now we can see that the recent deficit spending, while immense, is not really on par with deficit spending during World War II. As long as the government can get a handle on its revenue/spending balance within a few years, the US will likely recover, as it has a vastly increased ability to pay compared to the post-WWII era debt-to-GDP ratio.

Wage Stagnation & Federal Revenues

The government gets its money primarily from the people. US citizens finance the government through taxes and the purchase of US Bonds and other instruments. Thus, if the people have less money, the government will very likely have reduced revenue as well.

Here is a graph depicting GDP per Household and Median Income from 1967 to 2011:

GDP per Household has nearly doubled, while Median Income has increased only about 19% since 1967.

We can see above that the blue line (GDP per Household) has been increasing at a higher rate than the green line (Median Income) over this period.

This seems to indicate that the total dollar value of goods and services the US produces has increased more rapidly than the earnings workers take home.

The above shows GDP per capita (the blue line) and Federal Budget Revenue (green bars), again running from 1929 on the right, to 2012 on the  left.

There are actually two axes on this graph, since the GDP is actually much larger than the entire Federal Budget, I had to scale these so we can see the direct correlation between GDP and Federal Revenue. 

Let's have a closer look at just the last 35 years:

What exactly is happening? Mainly, since wages haven't increased with inflation and top income tax rates were slashed by both Reagan and George W. Bush, there have been long-term reductions in Federal Revenue, even though there has been an increase in GDP. 

The only point after 1984 in which the correlation between Federal Revenue and GDP returned to normal was between 1998 and 2001, when unemployment was very low and tax rates were moderately higher.

In FY2011, the government instituted a Payroll Tax holiday, reducing rates temporarily from 6.2% to 4.2%. The Payroll Tax accounts for all funds deducted from a wage-earner's paycheck for Social Security, Medicare and Unemployment Insurance. 

This was a great relief for many wage earners who got to take a larger portion of their income home, and was meant to stimulate spending. There is disagreement over whether it had the desired effect or not. The tax holiday expired in 2013.

Together with the Bush Tax Cuts, the Payroll Tax holiday, increased defense spending (since FY2000 the Defense Department's budget nearly tripled) and the Financial Meltdown/Great Recession, the US government has experienced a rapid increase in annual expenditures but a large net reduction in revenue.

In FY2000 expenditures were $2.3 trillion while revenues were $2.6 trillion-- and the budget ran a $300 billion surplus (in 2011 dollars). Expenditures in FY2010 were $3.5 trillion, while revenue had sunk to $2.16 trillion.

The net reduction in revenue by 2010 was over $500 billion while expenditures increased by $1.2 trillion, leaving a $1.4 trillion deficit. The next year, FY2011, was only slightly better:

US Federal Budget expenditures enacted for FY2011 were $3.63 trillion, but revenues totaled only about $2.3 trillion, leaving a deficit of $1.3 trillion.

Seemingly, the key to making the US Federal budget balance without significantly raising taxes is to somehow encourage wages to rise at pace with GDP-- or at least with inflation. That way, the bulk of the population would pay the same rate in taxes but ultimately provide more revenue for the government while reducing government expenditures.

Discretionary Spending amounts to about half of total Federal expenditures each year. FY2013 is expected to run a deficit under $1 trillion, for the first time since the Financial Crisis.

Does China Own the United States?

I hear a lot about China from pundits and fanatics. China does not "own" the US. They have lent the US government around $1.2 trillion- the largest amount of any single foreign government (although Japan is a very close second, at $1.1 trillion), and it would be crippling for the US to have to pay it all back at once, but:

#1- The debt to China is not a significant amount of the total US National Debt to begin with (only about 7%), and;

#2- That's not how it works. China owns a significant amount in US Bonds and Treasury Bills, which must mature to their term. The only thing the US has to worry about is issuing the annual interest on the bonds. They cannot be paid-out on demand. If China was interested in "cashing them in," they could be sold to other nations or investors. 

Sources: 
http://treasurydirect.gov/NP/BPDLogin?application=np
http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt

In the aftermath of World War II the US dollar became the number one global reserve currency. Countries all over the world use the dollar to pay debts to each other, most commodities are priced and traded in dollars internationally, and the value of many foreign currencies are pinned to the US dollar. 

It does not serve the interests of any nation to allow the United States to fail or to otherwise default on its debts. Nobody wants that-- especially not China; we're their biggest customer. If the US were to fall into financial ruin, it would likely ruin the Chinese economy as well.


The Federal Debt: A Menace to Society?


Despite the whining and grandstanding in Washington D.C., the US government is not about to go broke. Is it heading down an unsustainable path? Absolutely. But it's not simply all about spending, it's how the government spends the money, coupled with an insufficient revenue stream; the budget gap needs to be closed. In terms of international finances, however, it's doing alright for now. 

It could be a disaster if the US's credit rating was downgraded (like it was following the Debt Ceiling debacle last year), if the international community lost faith in the dollar, and/or if the US was otherwise forced to borrow at progressively higher and higher interest rates.


Further, and this may seem reckless, but as a last resort the government can always print more money. On the one hand, inflation is bad because it can stagnate wages while raising consumer prices- but on the other hand, if interest rates on government bonds are low enough (and they've been just about as low as they can get for ten years), inflation can outpace the interest on the government's debt, essentially amounting to negative interest.

However, in the case of the most recent Financial Crisis (as with the Great Depression), the issue of concern has been to avoid massive deflation. The US government has responded to this crisis by buying up large quantities of financial assets from banks, which can shore up the banks' short-term position and spur lending while indirectly increasing the money supply without affecting interest rates. See: Quantitative Easing.

Sadly, the US Federal Budget continues to grow, no matter who is president, no matter what party is in office, no matter who is sitting in Congressional seats-- at a rate usually between 3% and 7% per year. Statements claiming otherwise are just political posturing.

In fact, the only year since FY1965 that the US Federal Budget shrank from one year to the next was FY2010, and that was mostly because TARP (read as: an extra $700 billion) appeared on the FY2009 budget.

The United States government's deficit spending is a concern, but it is not yet a crisis. In times of economic turmoil, deficit spending can ease the woes of wage earners and stimulate economic growth by contributing directly to the GDP through contracts to defense companies, providing social insurance benefits that ensure consumers spend money into the economy (even if they're still unemployed), and infrastructure development that includes big payouts to private contractors. 

All of these government actions create a multiplier effect in which the economic output is greater than the total dollar amount of input. Government spending causes growth in the economy (especially through infrastructure projects), which generally causes companies to hire more employees, who earn more money (increasing Federal Revenue) and then spend most of it, increasing economic activity, which prompts businesses to hire more employees... and so forth.

Further down the road, if the US can make some policy changes that further economic development (including encouraging wage growth that at least keeps up with inflation) and if the government can increase its tax revenues without burdening the Middle Class and lower classes, there is a good chance that the current substantial deficit spending and the National Debt in general will not be a problem at all.

Exactly how to do all of these things is another matter-- it is a complicated macro-economic problem, and we'll get back to it later. Meanwhile, here's a great video on the topic of government debt by John Green of the vlogbrothers.